5 Financial Reform in Central Asia: Lessons from the Kyrgyz Republic

Laura Wallace
Published Date:
May 1997
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Tetsuji Tanaka

Before we can decide whether or not the financial reform experience of a Central Asian country can be of some help to the structural reform of an African economy, we must understand the differences between the basic conditions prevailing in the Central Asian countries and those in African countries. Noteworthy in this context is that the Central Asian countries, which became independent from the former Soviet Union in 1991, already had an established socialist economic structure, and thus we cannot say that they had to develop their economies from scratch.

Even so, the Central Asian economies have been faced with two challenges: one has been to transform themselves from centrally managed economies to market-oriented ones; and the second, much like developing countries striving for a market-oriented economy, has been to achieve a take-off of their economies. In my remarks today, I would like to focus on the Kyrgyz Republic’s experience with financial reform. As you perhaps know, I served as Special Economic Advisor to President Akaev of the Kyrgyz Republic and also as General Advisor to the National Bank, which is the central bank of the Kyrgyz Republic, from 1993 to 1995. For the first year, I was dispatched under the auspices of the IMF.

Reform of the Financial System

Under the monobanking system of socialist economies, national banks served only as a distributor of public funds—not providing the financial services so necessary for a market economy. Since a financial system provides a critical underpinning for a market economy, the government and central bank should be responsible for providing it.

In the Kyrgyz Republic, President Akaev and the Governor of the National Bank have been most eager to accomplish the transition to a market-oriented economy and thus have actively promoted various financial reform measures based on the recommendations of the IMF and World Bank. This type of initiative and leadership of senior government officials is essential if countries hope to succeed in reforming the financial system. What has been accomplished so far? Let me tell you of the achievements to date.

  • Introduction of a two-tier banking system. In 1991, the Kyrgyz branch of Gosbank became the central bank of the Kyrgyz Republic following a change in the organizational structure of Gosbank of the USSR, and a two-tier banking system—a central bank and commercial bank sector—was introduced.
  • Enactment of banking laws. In December 1992, the “Law on the National Bank” and the “Law of Bank and Banking Activities” were enacted. Based on these laws, 21 commercial banks were subsequently established. (In addition to the central bank, there are currently 18 commercial banks.) Three of these commercial banks, which were formerly national banks—the Agricultural Bank (Agroprombank),1 the Industrial Bank (Promstroibank), and the AKB Kyrgyzstan—account for 80 percent of total assets. Four of these banks are joint ventures with foreign capital.
  • Introduction of monetary policy measures. The National Bank is responsible for monetary policy and banking supervision and regulation. Within a short period, it had put in place credit auctions, a Lombard credit facility, emergency credit, treasury bill auctions, reserve requirements, and foreign exchange operations. In some cases, however, such monetary policy measures have not worked well because commercial banks have been short of funds and financial markets are still undeveloped.
  • Issuance of national currency. To avoid the adverse influence from the fluctuation of the ruble and to establish an independent financial system, the central bank issued a national currency, the som, in May 1993, ahead of other Central Asian countries. Although the exchange rate was initially 4 som per U.S. dollar, it depreciated to 12 som per dollar at one time, before stabilizing at about 10 in May 1996.
  • Establishment of a securities exchange system. In August 1994, the Coupon Trading Center was established to deal in coupons issued to promote privatization and, in May 1995, a stock exchange was established—although, to date, fewer than ten companies have listed their stocks.

Another major challenge for the Kyrgyz Republic will be to organize a payment system, as currently it takes about one week to remit funds domestically from one bank to another by mail. The financial authorities plan to establish an electronic funds transfer system. But first they are promoting a clearinghouse project as a short-term plan, and then they will embark on a gross settlement system project in which all financial institutions will participate. Though these projects face some difficulties, such as a shortage of expert staff and funds, the Japanese government and the European Bank for Reconstruction and Development are providing support.

The government must also contend with the commercial banks’ large amount of nonperforming loans, mainly to former national companies as a heritage of the former Soviet Union. Such loans should be written off for a while, but that practice has been temporarily suspended and instead the banks are being asked to distinguish such loans from newly extended loans. According to the recent classification, loan losses are 20 percent of total loans, and if substandard and doubtful loans are added, the figure is 90 percent. To write off such nonperforming loans, the World Bank has implemented the PESAC plan (Privatization and Enterprise Sector Adjustment Credit, worth $60 million, in 1994) for national companies in the red and the FINSAC plan (Financial Sector Adjustment Credit, for $15 million, in 1995)—although I think neither will be easy to finalize.

Shock Therapy and Effects

For the economy as a whole—which has been suffering from economic stagnation and accelerated inflation—the Kyrgyz government agreed in 1993 to promote rapid privatization and conduct a tight fiscal and monetary policy on condition that the IMF extend a standby credit and provide an arrangement under the systemic transformation facility (STF). Keeping to its end of the bargain, the central bank restrained lending to commercial banks, so much so that commercial banks fell short of funds and banknotes, even for the payment of salaries. In a country where bank deposits are few and small and the financial market is not developed, tight control of money supply may directly affect cash flow.

As a result of such consistent shock therapy, hyperinflation, which had reached 1,300 percent a year in 1993, was brought down to 32 percent in 1995, and the som has been fluctuating at about 10 per U.S. dollar for the last two years. At the 1995 Annual Meetings of the IMF and the World Bank, this achievement was highly praised as a model for the Commonwealth of Independent States. I can conclude that such shock therapy contributed to the end of hyperinflation and the stability of the som at home and abroad.

However, funds for long-term plant and equipment investment to increase production have become scarce due to high interest rates and a liquidity crunch, GDP in 1995 dropped to less than 50 percent of the pre-independence level, and living standards have worsened considerably. Deciding when to stop shock therapy and introduce fiscal and monetary policy to boost production requires care and tact, and countries must take into account the level of accumulated capital, the maturity of market participants, and the stage of market development.

Necessity of Government Intervention

Despite all the steps that the Kyrgyz Republic has taken in recent years on the financial front, I cannot conclude that it has made much progress. First, the financial market is still very rudimentary: large banks that were formerly national banks take a cautious lending attitude or are even reluctant to extend loans given their large amount of nonperforming loans, while smaller banks are short of funds and lack measures to manage credit risk. Second, only three or four banks are even equipped to handle foreign exchange business. Third, rapid liberalization and privatization have resulted in the stagnation of production and chaotic living conditions. Fourth, persistent tight monetary policy has resulted in the shrinkage of plant and equipment investment. Fifth, the reduction of the import tariff to 10 percent has increased the degree of dependence on imported consumption goods from 40 percent before independence to 80 percent at present. And sixth, foreign currency reserves are being depleted.

What can be done? In this instance, the experiences of Japan and East Asian countries, which also had to embark on reform with scarce accumulated capital, may serve as a good reference point for Central Asian countries. One key to their success was channeling public funds to the market and letting the government set priorities for distributing the funds.

In deciding the degree of market intervention and commitment by the government, we should consider various factors, including the stage of development of individual national economies, the number of market participants, the degree of market maturity, the market practices, and history, culture, and religion. In this context, it is worth noting that in Uzbekistan, which introduced relatively moderate shock therapy, production did not stagnate compared with the Kyrgyz Republic, because moderate shock therapy did not completely harm the management of production.

However, once a market matures, the government should refrain from intervening as much as possible. Accordingly, the laws and guidelines related to economic activities in a developing market should be effective for a limited period.

The Spirit of Capitalism and the Manas Spirit

There is no question in my mind that historical and cultural conditions influence both the possibility of a shift toward a market economy and the pace of reform. It is said that ethics and a philosophy that includes asceticism are required to operate a capitalist market economy. According to German sociologist and economist Max Weber, capitalism in Europe at the end of the 19th century was supported by Protestant ethics. With respect to Japan and East Asian countries, some say that Confucianism has played an equivalent role. Although Confucianism helped maintain strong national power in the feudal era, which held back the establishment of a modern state, it can be said that on the level of individuals and families, Confucianism has nurtured the necessary stoicism and desire to abide by contracts. In the Kyrgyz Republic, there is a long folk epic of 500,000 lines called Manas Epoth, which extols such virtues as diligence, saving, abiding by contracts, and service to the community. I expect the Manas spirit to be in the forefront of ethics in the Kyrgyz Republic.

A market participant must also be “ascetic”—laying aside his own interests—and “fair” from a social point of view. This is especially applicable to technocrats in charge of economic and financial matters since they lead the market. They should not attach too much importance to the interests of particular groups, be they political, regional, tribal, or family. Along this line, it is important to establish an educational institution and framework for overseas study that would foster the development of technocrats in charge of economic and financial matters with a high degree of integrity.


Agroprombank was suspended in 1996.

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